American Journal of Business Management, Economics and Banking ISSN (E): 2832-8078 Volume 22, | March - 2024 P a g e | 198 www.americanjournal.org THE IMPACT OF INTEREST RATE AND FOREIGN EXCHANGE CHANGES ON PUBLIC DEBT IN IRAQ Lect. Dr. Jabbar Saadoon Darag AL-Nahrain University Baghdad, Iraq Email: jabbar.saadon@nahrainuniv.edu.iq. A B S T R A C T K E Y W O R D S The study analyzed the reciprocal relationship between changes in interest and foreign exchange rates and public debt in Iraq during the period from 2004 to 2023. The research included the concept of public debt, the interest rate and the factors affecting it, the concept of the exchange rate and the factors affecting it, as well as the concept and importance of public debt. Data were used from the Central Bank of Iraq for the period (2004- 2023). The study found that there was a relationship between the independent variables represented by the interest rate and the exchange rate on public debt in the short term and the long term. The cointegration program was used, and an autoregressive study of distributed time gaps using ARDL test. Publicc debt, exchange rate, inflation, ARDL. Introduction According to the government, the outstanding Iraqi public debt amounts to $76 billion, of which $55 billion is domestic debt and $21 billion is foreign debt. The Iraqi government said that the public debt will be paid through federal government appropriations and the issuance of government bonds and treasury bonds. As oil prices fell repeatedly after 2014, the government needed domestic debt to finance public expenditures. The Central Bank of Iraq owns 63% of the local debt in the form of government bonds and treasury transfers, while the remaining 37% is held by 3 government banks: Al-Rafidain, Al-Rasheed, and Al- Iraqi Trade, on the one hand, and the role of the exchange rate and interest rates in moving Iraqi economic activity, on the other hand. Assuming there is a sound policy in the Iraqi economy. 1.1. the study Problem: Given the mutual influence between fiscal policy and monetary policy and the inevitability of coordination between them, especially in light of domestic consumption pressures, difficulties in American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 199 www.americanjournal.org developing and exploiting potential savings, and the decline in foreign investment flows, especially after problems emerged due to concerns about the currency, insufficient control over inflationary trends, rising prices, and increasing public debt. It can have numerous economic consequences, which may lead to an imbalance in the effective distribution of available resources to different sectors of the economy. 1. 2. Study hypothesis: The study aimed to test a basic hypothesis: There are direct and indirect relationships between changes in interest rates, foreign currencies, and domestic and foreign public debt) and the basic hypothesis leads to a number of sub-hypotheses: Higher domestic interest rates increase domestic public debt. High foreign exchange rates lead to an increase in external public debt. 1 .3. Objectives of the study: In addition to testing the basic hypothesis, the study aimed to: Determine the theoretical framework for studying the main variables, where interest rates and foreign currencies are considered independent variables and public debt is the dependent variable. Estimating the quantitative relationship between interest rates and foreign currency changes in public debt, as well as identifying general trends for each of the main study variables and some macroeconomic variables such as (GDP growth, saving,...). 2. Previous studies: - Faraj Abdel Rahman, Hosni Mahran, 2020, The impact of interest rate and foreign exchange changes on public debt in Egypt. The study reached a set of results, most notably the presence of an indirect effect of the decline in economic growth on the development of public debt through the decline of the tax revenue channel in the general budget, With the existence of a reciprocal relationship, as interest rate increases lead to an increase in public debt through the general budget deficit variable as an intermediary variable, and it was also shown that the impact of the exchange rate on foreign public debt in the short term is weak, compared to the high impact of the interest rate on the development of domestic public debt from Through the channel of public debt burdens as one of the items of public spending, it was also observed that there is an indirect effect of gross domestic saving on public debt through the channel of interest rates on the one hand, and the decline in gross domestic product on the other hand, which indicates that the impact of changes in interest rates is more The effectiveness of the impact of changes in exchange rates on public debt, both domestic and foreign. - Bidaa Jawad Kazem, Alaa Jassim Muhammad, measuring the impact of public debt on the exchange rate in Iraq, for the period (2004-2022). The study reached a number of conclusions, perhaps the most prominent of which is the existence of a direct relationship between government debt, both parts (internal and external), on the parallel exchange rate. in Iraq . - Maryam William Barsoum, 2022, study of some economic variables and their impact on the size of the local public debt in Egypt during the period from, it was found that the size of the local public debt is greatly affected by some economic variables that were used in the statistical model and that there is a very strong correlation with the tax revenue, as it represents one of The most important American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 200 www.americanjournal.org sources of revenues and the extent of their contribution to financing public debt, both domestic and external, which leads to a decrease in the deficit in the state’s general budget. 3. The theoretical framework of public debt, exchange rate, interest rate. 3. 1. The concept of public debt The exacerbation of the debt problem has emerged as one of the most prominent problems faced by countries, especially developing countries, including Iraq. It has transformed from a mere problem into a chronic crisis, especially after the crises that the country has been exposed to, which resulted in a tendency towards excessive domestic borrowing, in addition to external debt, (Badr, Majid Farhan, 88, 2007). Public debt refers to everything that public entities in the country borrow from others, whether locally or externally. To finance its business; Due to the inability of its own resources to meet the expenses required by these works, public debt is a global phenomenon that is acceptable to a certain extent according to certain controls, but if the debt exceeds this limit and deviates from these controls, it becomes a problem, and the matter may even escalate into a crisis that leads to... There are bad effects and great risks on public funds and on the national economy as a whole. Intellectual trends differed regarding the limit of public debt to GDP, but there are some studies that indicate that the acceptable limits of debt do not exceed 70% of GDP (Zardag, 2009). Therefore, local public debt represents the financial burdens that the government is committed to before national economic units operating in the local market. Here, the government means the central government, local units, and economic and service bodies. Local public debt is often the result of government borrowing from the local market and in the national currency in accordance with national legislation. Therefore, we find that the state is the one that imposes the conditions it desires, and is not subject to external influences when issuing these loans, (Sattar Jabbar Al-Bayati, Diana Hashem Jassim, 208, 2022). As for external public debt, the Central Bank of Iraq indicates that it is the current, actual discounted amount based on residents in an economy at a certain time, for non-residents, which requires making payments on the part of the debtor to pay interest or principal amounts at points of time in the future (Abdul Latif Iman Muhammad, 77, 2017). It can be said that the public debt in Iraq has reached a stage that requires study, as a result of what Iraq, like other developing countries, suffers from a deficit in its public budget, where the side of public expenditures exceeds the side of public revenues, and this is either due to misuse of public revenues or due to a significant increase in the growth in public expenditures. far exceeds the growth in public revenues; Due to the presence of a continuing deficit in the state’s general budget, the matter requires resources; To finance this deficit so that the state can carry out its work according to established development plans and programmes. Most of this deficit was financed through domestic public debt to a greater extent than external public debt (Muhammad, Muhammad Mustafa Al-Banna, 132, 1980). 3. 2. Interest rate It is the price that the central bank pays on commercial bank deposits, whether they are an investment for one night or for a month or more.[1][2][3] This price is an indicator of the interest rates of commercial banks, which should not be less than the central bank rate. The interest rate also helps American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 201 www.americanjournal.org the central bank control the supply of money in circulation by changing this price up and down in the medium term. Raising interest means curbing borrowing operations and thus reducing the liquidity ratio in the market, which leads to a reduction in the inflation rate (Nima, Samir Fakhri, 66, 2018). The interest rate is defined as the return on the investor’s capital through the price that a person obtains as a result of waiving the disposal of his money that he lends for a specific period of time. This price varies according to the period, whether monthly or yearly, and according to the amount borrowed. The longer the borrowing period, the greater the risk potential. Accordingly, the interest rate is determined by the agreement of the lender and the borrower and based on supply and demand, because increasing the supply of capital will reduce the interest rate and vice versa. Accordingly, the quantity of money and its turnover rate have a role in the quantity of money supplied, and the financing, precautionary and speculation motives also have a role in determining demand. On money. The bottom line is that interest rates are the return on investing money for a specific period of time in exchange for the lender’s waiver of disposing of his money throughout the period of calculating the return, which is often annual (Ahmed, D. A., 20, 2012). . 3. 2. 1. Factors that determine the interest rate: Interest rates are determined based on the forces of supply and demand. If demand rates for the money on offer rise, it will lead to higher interest rates and at the same time will reduce lending rates in the economic circle. Interest rates are affected by the size of their rise and fall within the various financial markets, as the financial markets are interconnected as a result of the movement of funds within these markets. The financial market, which is characterized by high interest rates, attracts capital to it in search of higher profitability, so the supply of these funds increases, and this in turn leads to a reduction in the price, i.e. The interest rate responds to the forces of supply and demand. At the same time, low-interest markets expel capital, resulting in a decrease in its supply, which is a factor in the interest rate rising. The prosperity of the economic situation also results in a rise in interest rates, as interest rates tend to rise in every period in which economic institutions need financing in response to the increase in production required by the economic recovery, so the demand for capital increases, which works to raise the price (DIOP, Ndiame; GHALI 23, 2012).. 3. 3. exchange rate : In order to define the exchange rate, we must know that there are two types of exchange rates. There is a fixed exchange rate, which is determined by the state and does not change with changing economic conditions. The government determines the value of its own currency and these prices are not affected by any other factors. It is considered one of the most important... The countries that set a fixed exchange rate for the currency are the oil-exporting countries of the Arabian Gulf, as these countries set a fixed exchange rate on their own local currencies (Hanan Hassan Mustafa, Hajir Adnan Zaki, 126, 2023), but what makes the local currency Strong in this case is that they have an economy that depends on natural resources that make their local currency strong. On the other hand, industrialized countries liberalize the exchange rate in order to compete with other industrialized countries, as the exchange rate affects the prices of products, which greatly affects the export of products abroad. Therefore, it is better for countries that liberalize exchange rates for the price of the currency to be compatible with the value of the product and provide the global consumer with value for price (TOMOVA, Mariana, 125, 2013). American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 202 www.americanjournal.org 3. 3. 1. Factors affecting the exchange rate: The reasons for the rise and fall of the currency price are due to the expected strength of the country’s economy, as the exchange rate in industrialized countries is determined based on the concept of supply and demand, where an increase in supply leads to a decrease in the value of the exchange rate and demand leads to an increase in the value of the currency at the exchange rate, and therefore central banks It monitors the volume of liquidity offered in the local currency and increases the supply of the local currency or withdraws it from banks according to the need to determine a high or low exchange rate. Some countries also set a fixed exchange rate that is determined in advance by the central bank and change it as needed through The Central Bank’s vision of the value of the currency (Ibrahim, Nevin Farag, 90, 2015). There are many factors that determine the exchange rate, all of which are related to the trade relationship between two countries. Remember, exchange rates are relative and are expressed as a comparison between the currencies of two countries. Below are some initial determinants of currency exchange rates between two countries. Note that these factors are not in any particular order, and as with many economic principles, the relative importance of these factors requires much debate (DORNBUSCH, Rudiger, 1984). 4 Statistical analysis 4.1. Data examination: Data can be examined, using measures of central tendency, measures of dispersion, a normal distribution test, and graphs. All of these statistical operations are considered part of data examination. Descriptive statistics can be clarified for the dependent variable represented by public debt, and the independent variables represented by the exchange rate and the interest rate. . 4. 1. 1. Table No. (1), normal distribution of the independent variables (ER, I), and the dependent variable (PB). ER I PD Mean 124.7500 7.125000 27710358 Median 117.5000 6.000000 9350413. Maximum 147.0000 20.00000 69912394 Minimum 116.0000 4.000000 4255549. Std. Dev. 12.24691 4.495246 25813404 Skewness 0.994699 1.841709 0.587017 Kurtosis 2.176448 5.183845 1.717921 Jarque-Bera 3.863288 15.28062 2.518400 Probability 0.144910 0.000481 0.283881 Sum 2495.000 142.5000 5.54E+08 Sum Sq. Dev. 2849.750 383.9375 1.27E+16 Observations 20 20 20 From the table above, it is shown that the exchange rate and public debt follow a normal distribution, with Probability being greater than 1% and greater than 5%, while the interest rate variable does not follow the distribution, being Probability is less than 5%, and therefore we accept the alternative hypothesis and reject the null hypothesis. . American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 203 www.americanjournal.org 4. 1. 2. Table No. (2) Normal distribution of the interest rate variable. 0 2 4 6 8 10 2.5 5.0 7.5 10.0 12.5 15.0 17.5 20.0 22.5 Series: I Sample 2004 2023 Observations 20 Mean 7.125000 Median 6.000000 Maximum 20.00000 Minimum 4.000000 Std. Dev. 4.495246 Skewness 1.841709 Kurtosis 5.183845 Jarque-Bera 15.28062 Probability 0.000481 The interest rate does not follow a normal distribution, since Probability (0.000481) is less than 5%, and therefore we accept the alternative hypothesis, and reject the null hypothesis. 4. 1. 2. Table No. (2) Normal distribution of the public debt variable. 0 2 4 6 8 10 12 100 20000100 40000100 60000100 Series: PD Sample 2004 2023 Observations 20 Mean 27710358 Median 9350413. Maximum 69912394 Minimum 4255549. Std. Dev. 25813404 Skewness 0.587017 Kurtosis 1.717921 Jarque-Bera 2.518400 Probability 0.283881 Public debt follows a normal distribution, with Probability (0.283881) being greater than 5%, and therefore we accept the null hypothesis and reject the alternative hypothesis. American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 204 www.americanjournal.org 4. 1. 2. Table No. (3) Normal distribution of the exchange rate variable. 0 2 4 6 8 10 12 14 115 120 125 130 135 140 145 150 Series: ER Sample 2004 2023 Observations 20 Mean 124.7500 Median 117.5000 Maximum 147.0000 Minimum 116.0000 Std. Dev. 12.24691 Skewness 0.994699 Kurtosis 2.176448 Jarque-Bera 3.863288 Probability 0.144910 The exchange rate follows a normal distribution, with Probability (0.144910) being greater than 5%, and therefore we accept the null hypothesis and reject the alternative hypothesis. 4. 2. Unit root test 4. 2 .1 . Table No. (4) Interest rate static test Null Hypothesis: I has a unit root Exogenous: Constant, Linear Trend Lag Length: 1 (Automatic - based on SIC, maxlag=1) t-Statistic Prob.* Augmented Dickey-Fuller test statistic -4.620279 0.0091 Test critical values: 1% level -4.571559 5% level -3.690814 10% level -3.286909 *MacKinnon (1996) one-sided p-values. Warning: Probabilities and critical values calculated for 20 observations and may not be accurate for a sample size of 18 Augmented Dickey-Fuller Test Equation Dependent Variable: D(I) Method: Least Squares Date: 01/12/24 Time: 21:40 Sample (adjusted): 2006 2023 Included observations: 18 after adjustments American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 205 www.americanjournal.org Variable Coefficient Std. Error t-Statistic Prob. I(-1) -0.812524 0.175860 -4.620279 0.0004 D(I(-1)) 0.711969 0.176509 4.033617 0.0012 C 10.66520 2.653346 4.019531 0.0013 @TREND("2004") -0.450975 0.146405 -3.080329 0.0081 R-squared 0.659275 Mean dependent var 0.027778 Adjusted R-squared 0.586262 S.D. dependent var 3.457610 S.E. of regression 2.224020 Akaike info criterion 4.629640 Sum squared resid 69.24771 Schwarz criterion 4.827500 Log likelihood -37.66676 Hannan-Quinn criter. 4.656922 F-statistic 9.029602 Durbin-Watson stat 0.947072 Prob(F-statistic) 0.001403 From the table above it is clear that the interest rate is static at the original level and at the longest model (Constant, Linear Trend), and a slowdown rate of 1,The interest rate, Probability (0.0091), will remain at 1%. 4. 2 .2 . Table No. (5) Exchange rate static test. Null Hypothesis: ER has a unit root Exogenous: Constant Lag Length: 1 (Automatic - based on SIC, maxlag=1) t-Statistic Prob.* Augmented Dickey-Fuller test statistic -3.193285 0.0374 Test critical values: 1% level -3.857386 5% level -3.040391 10% level -2.660551 *MacKinnon (1996) one-sided p-values. Warning: Probabilities and critical values calculated for 20 observations and may not be accurate for a sample size of 18 Augmented Dickey-Fuller Test Equation Dependent Variable: D(ER) Method: Least Squares Date: 01/12/24 Time: 21:43 Sample (adjusted): 2006 2023 Included observations: 18 after adjustments Variable Coefficient Std. Error t-Statistic Prob. ER(-1) -0.471040 0.147509 -3.193285 0.0060 D(ER(-1)) 0.472934 0.219500 2.154594 0.0479 C 57.20933 18.24065 3.136365 0.0068 American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 206 www.americanjournal.org R-squared 0.436417 Mean dependent var -0.833333 Adjusted R-squared 0.361273 S.D. dependent var 8.382405 S.E. of regression 6.699254 Akaike info criterion 6.792881 Sum squared resid 673.2000 Schwarz criterion 6.941276 Log likelihood -58.13593 Hannan-Quinn criter. 6.813343 F-statistic 5.807710 Durbin-Watson stat 2.004516 Prob(F-statistic) 0.013558 From the table above it is clear that the exchange rate is stationary at the original level (Constant), and it slows down by 1, The exchange rate, Probability (0.0374), remains at 5%. 4. 2 .3 . Table No. (6) Stagnancy test of public debt Public debt remains at the first level and in the broad model (without trend and intersection) Null Hypothesis: D(PD) has a unit root Exogenous: None Lag Length: 0 (Automatic - based on SIC, maxlag=1) t-Statistic Prob.* Augmented Dickey-Fuller test statistic -2.884185 0.0065 Test critical values: 1% level -2.699769 5% level -1.961409 10% level -1.606610 *MacKinnon (1996) one-sided p-values. Warning: Probabilities and critical values calculated for 20 observations and may not be accurate for a sample size of 18 Augmented Dickey-Fuller Test Equation Dependent Variable: D(PD,2) Method: Least Squares Date: 01/12/24 Time: 21:49 Sample (adjusted): 2006 2023 Included observations: 18 after adjustments Variable Coefficient Std. Error t-Statistic Prob. D(PD(-1)) -0.657066 0.227817 -2.884185 0.0103 R-squared 0.328554 Mean dependent var -8276.167 Adjusted R-squared 0.328554 S.D. dependent var 10942116 S.E. of regression 8966166. Akaike info criterion 34.90977 Sum squared resid 1.37E+15 Schwarz criterion 34.95923 Log likelihood -313.1879 Hannan-Quinn criter. 34.91659 Durbin-Watson stat 1.783489 American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 207 www.americanjournal.org From the table above it is clear that the public debt is stationary at the original level and at None, that is, without (Constant, Linear Trend), and a slowdown of 1, since it is stationary at the first level and not at the original level. The public debt is stationary (Probability 0.0065), at the level of 1. %. 4.3: Cointegration test 4. 3. 1 . Table No. (7), Johansen model test between the independent variables and the dependent variable. Date: 01/12/24 Time: 22:02 Sample (adjusted): 2006 2023 Included observations: 18 after adjustments Trend assumption: Linear deterministic trend Series: PD ER I Lags interval (in first differences): 1 to 1 Unrestricted Cointegration Rank Test (Trace) Hypothesized Trace 0.05 No. of CE(s) Eigenvalue Statistic Critical Value Prob.** None * 0.925202 53.64477 29.79707 0.0000 At most 1 0.307878 6.971354 15.49471 0.5810 At most 2 0.019119 0.347474 3.841466 0.5555 Trace test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon-Haug-Michelis (1999) p-values Unrestricted Cointegration Rank Test (Maximum Eigenvalue) Hypothesized Max-Eigen 0.05 No. of CE(s) Eigenvalue Statistic Critical Value Prob.** None * 0.925202 46.67342 21.13162 0.0000 At most 1 0.307878 6.623880 14.26460 0.5345 At most 2 0.019119 0.347474 3.841466 0.5555 Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon-Haug-Michelis (1999) p-values Through the table above, the results appear, and it has two parts, the first is Statistic Trace and the second part is Statistic Max-Eigen. In the first part, one cointegration vector appears, which is None * and it is significant (0.0000 Probability), and it was confirmed through Statistic Trace (53.64477). It is greater than (29.79707Critical Value), and therefore we judge that the model is significant American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 208 www.americanjournal.org regardless of the second and third vectors, and therefore we reject the null hypothesis and accept the alternative hypothesis. 4. 3 .2 . Table No. (8) Autoregressive test for distributed time lags using test ARDL. Dependent Variable: PD Method: ARDL Date: 01/12/24 Time: 22:18 Sample (adjusted): 2005 2023 Included observations: 19 after adjustments Maximum dependent lags: 1 (Automatic selection) Model selection method: Akaike info criterion (AIC) Dynamic regressors (0 lag, automatic): ER I Fixed regressors: C Variable Coefficient Std. Error t-Statistic Prob.* PD(-1) 0.970499 0.113339 8.562779 0.0000 ER -66684.51 213992.8 -0.311620 0.7596 I -500741.7 552263.8 -0.906708 0.3789 C 15952558 24504571 0.651003 0.5249 R-squared 0.898508 Mean dependent var 28849762 Adjusted R-squared 0.878209 S.D. dependent var 25998902 S.E. of regression 9073239. Akaike info criterion 35.06422 Sum squared resid 1.23E+15 Schwarz criterion 35.26305 Log likelihood -329.1101 Hannan-Quinn criter. 35.09787 F-statistic 44.26478 Durbin-Watson stat 1.566162 Prob (F-statistic) 0.000000 *Note: p-values and any subsequent tests do not account for model selection. Through the table above, we see the significance of the model through (0.0000 Probability), public debt regardless of the lack of significance of the two independent variables, the interest rate and the exchange rate, in addition to that choosing the calculated F of 44.26478, (Prob F-statistic) 5. Results and recommendations 5.1. Results 1- There is a relationship between public debt and interest rate changes with respect to domestic public debt, and foreign exchange rate changes, and with respect to foreign public debt. 2- It has also been shown that the rise in local interest rates contributes to the rise in local public debt directly in the short term, while the impact of changes in foreign exchange diminishes. American Journal of Business Management, Economics and Banking Volume 22 March - 2024 P a g e | 209 www.americanjournal.org 3- While it has been shown that there is an indirect relationship between the foreign exchange rate and the local interest rate, as the rise in interest rates is characterized by flows of foreign investments in debt instruments, thus affecting reserves and then stabilizing the exchange rate in the short term. 5-2 Recommendations: 1- Searching for non-traditional resources to strengthen the state’s financial resources to prevent resorting to domestic or foreign debt. 2- Attracting the informal sector may accelerate the reduction of the financial resources gap in the long term, which requires serious support and incentives in the short term. 3- The state can launch projects and re-offer them to the private sector after achieving financial stability for these projects, which allows new financing opportunities that do not generate debt. 4- Continuing to support and launch sovereign investment funds contributes to generating relatively sustainable resources, which allows for the expansion of spending. 5- Expanding the tax base, not the tax bases, by targeting reform of the tax system on the one hand, setting spending ceilings for some general budget items, and activating the program and performance budgeting mechanism. 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